Telecom

Is Verizon's Bet on FiOS Paying Off?

Flip on the TV and you'll have trouble avoiding an ad for FiOS, Verizon Communications' (VZ) super-high-speed fiber-optic Internet and pay TV service. FiOS is Verizon's $23 billion answer to the declining land-line business and cable rivals' "triple play" of television, phone, and online. And FiOS is profitable, according to Chief Executive Officer Ivan G. Seidenberg. "We could easily double the amount of video customers we have on that platform over the next two to three years, and we're getting good margins on it," he said at a Citigroup (C) conference in Phoenix in January.

Now, however, there are reasons to question the notion that FiOS operates in the black. A recent asset sale suggests that FiOS may actually lose money. Moreover, industry analysts infer from Verizon's decision last year to stop pursuing new municipal franchises that all may not be well with the network. The company stands by its CEO's statement.

Last year, Frontier Communications (FTR) paid $8.6 billion to acquire 4.8 million Verizon access-line customers across 14 states, including FiOS subscribers in the Portland (Ore.) and Seattle areas. In January, Frontier essentially signaled that it was not making a profit on FiOS accounts at the prices Verizon was charging. Frontier sought regulatory approval for a 46 percent price increase for new FiOS TV customers and those with expiring contracts—$95 a month vs. the $65 Verizon was charging. An Oregon regulator objected, and that case is pending. In early March, Frontier said it intended to opt out of certain franchise agreements in its acquired territory and hike FiOS installation for new customers from $79 to $500. Says Frontier spokeswoman Brigid Smith: "I cannot say that we are losing money" at Verizon's prices. FiOS is still being offered in the Pacific Northwest, she says; the price increases haven't taken effect.

Frontier's proposed pricing moves suggest to Craig Moffett, a telecom analyst with Sanford C. Bernstein (AB), that FiOS does not turn a profit for Verizon, either. Moffett says his view is reinforced by Verizon's announcement in 2010 that it would effectively freeze its FiOS footprint. "It was a tacit admission that building new networks is a losing proposition," he says. "Frontier is saying that even operating them after they're built might not be worth it." He estimates the project will end up having cost Verizon $4,000 per connected home. Moffett calculates the present value of acquired subscribers at $3,200 each. That would give FiOS a negative $800 net present value per customer. "It's surely a nice, state-of-the-art network," says Thomas W. Hazlett, a telecommunications scholar at George Mason University in Arlington, Va. "But it is really expensive, and not that many households are willing to pay for the bells and whistles."

Verizon spokesman Bob Varettoni counters that the fiber investment turned cash flow-positive in 2008. The project boosted overall company margins in the first quarter of 2010, he adds. "Our FiOS initiative has higher [cash-flow] margins than our wireline segment as a whole. Therefore, FiOS is one of the drivers of improving wireline segment margins," says Varettoni. While he declines to respond directly to outside skeptics, he says that FiOS has a positive present value and generates returns on invested capital. In its January earnings release, Verizon said FiOS contributed 53 percent of consumer wireline revenue in the fourth quarter.

The discrepancy may boil down to cost accounting. A company the size of Verizon, with overall revenue of $106 billion, has discretion in allocating costs to various operations. All of which, says Moffett, shows that the "reported profitability of FiOS is of little use in assessing the underlying economics."

The bottom line: Verizon hopes FiOS will make up for a dying land-line business. The CEO says it's profitable. Others dispute his math.

Farzad is a Bloomberg Businessweek contributor. Follow him on Twitter @robenfarzad.